Will The Unthinkable Occur?

By: Kent Engelke | Capitol Securities

In the early 1980s, during an “Introduction to Political Science Class,” I was introduced to the concept that there are generational geopolitical/sociological changes every 35-40 years. I vividly recall discussing LBJ’s “Great Society” programs, the social angst of the Vietnam War, the nascent rise of globalism and the beginning of the close collusion between big government and big business and how such commenced a new era of activist and redistributionist government.

The professor stated these trends stay in place until there is some finale equivalent to the conclusion of a Fourth of July fireworks display where the current trend goes on steroids believing the status quo is all knowing and powerful. Radical change then occurs.

I believe I live in the congressional district that commenced the battle against the Establishment. David Brat defeated House Majority Leader Eric Cantor in a primary, a primary that Cantor all but dismissed as meaningless and unthreatening.

This was first time that a major leader was defeated in a primary since the late 1800s. Brat won because Cantor’s constituents — one of which is me — believed that Cantor lost contact with the electorate. That Cantor was all about himself and the perpetuation of the Establishment.

The professor dogmatically stated these changes will occur, not questioning as to if, but rather as to when.

Fast forward to today. Brexit. Trump. Italy. And now France.

For the first time in many generations, a candidate from a major political party is not in contention for France’s presidency. This would be equivalent to neither a Republican or a Democratic candidate being a candidate for the US Presidency.

On May 7th, France’s citizenry is faced with a dichotomy. The choice is a far right populist, who espouses economic nationalism and “Frexit,” or a moderate who supports closer ties to the EU. Neither candidate is from a national party and the moderate is a political neophyte who most thought had little chance of succeeding to the “finals” as little as 60 days ago.

In other words, a strong argument can be made the survival of “The Federation” is at hand. There is a clear battle between a commitment to dramatically changing the current economic system or one to maintain the existing structure.

To write the obvious, the entire Establishment is supporting the moderate and at this juncture is projected to win by a considerable margin.

Will Le Penn do the unthinkable and win?

Why the attention on this election? Today’s financial system is predicated upon globalism. The top performing equity issues are mega capitalized global growth issues, a term that I find oxymoronic. According to Bespoke Investment Corporation, the concentration of wealth into a handful of mega sized global growth companies is unprecedented. What happens if globalism dies an inglorious death in 2 weeks?

Perhaps the only certainty to write is that regardless who is France’s next president, today is radically different than yesterday. The electorate is speaking very loudly and it is very anti-Establishment.

Equities advanced on the French election with many declaring that Le Penn will lose by a wide margin. I think I wrote these same words in late June 2016 referencing Brexit.

Last night the foreign markets were up. London was up 0.26%, Paris was up 0.38% and Frankfurt was up 0.03%. China was up 0.16%, Japan was up 1.08% and Hang Sang was up 1.31%.

The Dow should open nominally higher, perhaps the result of tax reform optimism. The 10-year is off 8/32 to yield 2.31%.


Possible Reasons For Hedge Fund Bearishness

By: Kent Engelke | Capitol Securities

More and more high profile hedge fund managers are warning about stock valuations. The reason for the concern is the breakdown of globalism, the concentration of wealth in a handful of companies, rising interest rates that will impact valuations, especially those issues trading at huge multiples, rising input prices that may not be able to be passed onto the end user and rising wages.

There is also rising concern about “portfolio insurance,” the domination of moving average lines to make instantaneous trading decisions and the total capitalization of the S & P 500 as compared to the size of the economy.

Those who are cynical are perhaps thinking current hedge fund bearishness could be the result of the lack of performance as compared to the benchmarks. The last major era of hedge fund out performance ended in 2007.

Passive portfolio management via ETFs has dominated since the financial crisis, a style that focuses more on size rather macroeconomic and geopolitical analysis.

I ask however if the change in today’s environment is indeed tectonic via the collapse of globalism, should this not create a more bullish environment for hedge funds that utilize an overriding thesis and research, thus becoming significant?

Several weeks ago, I noted the collapse of the security research industry, the result of the proliferation and domination of passive ETFs. Some believe such a collapse has created an opportunity for those firms that still follow trends and companies. This group believes the ETF/mega capitalization trade has become very crowded. When anything becomes this crowded, the next path is typically down.

The question at hand is if this trade collapses, what happens to all other issues?

I will argue it depends upon tax and regulatory reform. If reform occurs, such reform will directly benefit “The Main Street Issues” versus “The Wall Street Issues” for a myriad of reasons.

What will happen this week? Earnings season accelerates. The economic calendar is comprised of several regional manufacturing indices, consumer confidence, trade and more housing data, inventories and initial estimates of first quarter GDP.

Last night the foreign markets were up. London was up 1.72%, Paris was up 4.51% and Frankfurt was up 3.0%. China was down 1.37%, Japan was up 1.37% and Hang Sang was up 0.41%.

The Dow should open sharply higher on the results of the French election. The populist Le Penn is thought not to have a chance against the centralist Macron, a person she is casting as an oligarch. The election is on May 7th. The 10-year is off 15/32 to yield 2.31%.


Bill de Blasio Is Right

By: Kent Engelke | Capitol Securities

Did NYC’s mayor Bill de Blasio just make the Democratic Party case for lower taxes? The mayor is pushing to raise the price of cigarettes from $10.50 to $13.00 in an attempt to drastically reduce the number of smokers by 2020. The “progressive” mayor stated higher prices will cause lower demand, thus saving lives.

I do not know if the 25% increase will be treated as a tax—something in itself… it is very regressive given the preponderance of smokers earn less than $48,000 a year and can least afford an increase — but his rationalization is correct based upon Econ 101.

Higher prices/taxes dictate less demand.

Based upon almost every sentiment survey, President Trump is The Hope and Change President. Can this sentiment be transformed into increased economic activity?

I believe it depends upon tax and regulatory change. Perhaps the most progressive American mayor, the mayor of the nation’s largest city, inadvertently just made a strong case for lower taxes—tax something more, there is less demand and vice versa.

Will tax reform occur? The Establishment is against this type of change. Society is for it. Much emphasis has been placed upon the first 100 days of any administration, a vestige of FDR’s “first one hundred days” eighty-five years ago. Today, nothing occurs in 100 days, except major market transitions, the result of technology based trading where momentum is the primary variable. In my view, rarely is there any type of macroeconomic thesis followed.

The explosion of the ETF industry is incredible over the past decade. According to Credit Suisse, in 2006 there were 16 iShares funds globally that had more than $1 billion in assets and traded an average of more than $100 million day. Ten years later, 77 funds meet those criteria. Seven of the 10 most actively traded securities in the US last year were ETFs.


Yesterday, stocks staged an advance predicated by Treasury Secretary Mnuchin comments that a tax reform proposal will be made shortly. The comments had a large impact on the small capitalized issues. The Russell 2000 was precariously on support near the lows of the year. This small cap index is now bumping against the downtrend line off of the early March highs.

Last week I had referenced a Bloomberg article stating that short futures contracts on the Russell 2000 had grown the most since 2008.

I ask how much of the change is the result of algorithmic trading? What happens if ETFs enter the fray, the result of tax and regulatory reform that would greatly benefit Main Street America?

Based upon yesterday’s market action, Bill de Blasio is right. The more you tax an item, the less demand there is for that item. And vice versa.

Last night the foreign markets were up. London was up 0.10%, Paris was down 0.12% and Frankfurt was up 0.4`5. China was up 0.03%, Japan was up 1.03% and Hang Sang was down 0.06%.

The Dow should open flat ahead of Sunday’s vote in France. Earnings are continuing to paint a mixed picture on the health of the economy. The 10-year is unchanged at 2.24%.


A Possible Disconnect

By: Kent Engelke | Capitol Securities

Until an early afternoon sell off, oil prices were around their highest levels of the year. Conversely, oil shares are lagging oil prices and are greatly underperforming. The divergence between crude and share prices does not last for long. Either crude is going to drop or oil equity prices are going to rally.

The reasons for the divergence are numerous. Electronic based trading firms are programmed to interpret a drop in inventories as bearish as such supports a rise in production that will later suppress prices. The belief is that OPEC will not continue with production cuts. Global oil demand will not meet expectations. Or because oil is not technology.

Speaking of technology, according to Bloomberg, the S & P 500 technology index is at its 50 day moving average. As noted several times recently, there has been a major transition out of everything but technology into technology, thus suggesting a very imbalanced market. The Trump trade has been unwound.

Can the following scenario unfold? A mega capitalized technology growth company disappoints, selling commences in the technology sector and funds gravitate to oil and the financials? As noted above, the divergence between crude prices and oil securities normally does not last for long.

Yesterday IBM profits fell short of expectations, the major reason for the 100 point decline in the Dow. Oil also fell about 3.5% on mixed inventory data [note: oil initially advanced on the statistics].

Last night the foreign markets were mixed. London was down 0.04%, Paris was up 0.75% and Frankfurt was unchanged. China was up 0.04%, Japan was down 0.01% and Hang Sang was up 0.97%.

The Dow should open nominally higher partially on the news that the crude producing countries reached an initial agreement to extend output cuts. The 10-year is off 4/32 to yield 2.32%.


Change Is The Only Constant

By: Kent Engelke | Capitol Securities

US equities retraced Monday’s light volume advance, an advance I believe was the result of algorithmic or technology based trading. The reason for yesterday’s decline… a mega-sized financial missed profit expectation, a surprise call for an election in Britain to further strengthen Brexit, France’s election on Sunday where the populist and nationalist Le Penn is expected to be one of the two victors leading into the final voting in May and North Korea.

Treasuries continued to rally and are now around mid-November levels.

As written last week, the entire “Trump Trade” has been reversed with mega-capitalized growth issues out-performing. Value and the small caps are performing poorly as the immediate chances of Trump’s pro-growth agenda being passed are slim.

About two months ago, I commented that change will not occur immediately and any type of delay would be met with selling.

I believe the economy/the markets are at a major inflection point. An appropriate response would be no duh! Economic nationalism is gaining further momentum. Brinkmanship and saber rattling is at levels not experienced in almost 30 years.

The Financial Times quoting Bank of America/Merrill Lynch states interest rates are at 5,000 year lows. Moreover, BAML writes fiscal stimulus in the G-7 countries is at a 70-year low, further stating stock valuations are lofty but bank valuations are at 75-year lows, a huge disconnect. The amount of wealth concentrated in a handful of names is exponential.

But a transition to what? First quarter growth is now expected to be under a 1.5% handle, the result of the lack of pro-growth initiatives such as tax and regulatory reform. I believe such is already reflected in the small and value companies for such are the most sensitive to anemic domestic growth.

Most are extrapolating the last eight years, the last 25 years into perpetuity. The world is different today than yesterday. I reiterate because of hope lost in the global administrative state, economic nationalism will continue to evolve into the dominant economic philosophy and the domestic issues, rather than the global leviathans, will consistently outperform. Growth will exceed expectations as part of Trump’s agenda becomes legislated.

Radical thought? Maybe not, if change is the only constant.

Last night the foreign markets were mixed. London was down 0.24%, Paris was up 0.27% and Frankfurt was up 0.19%. China was down 0.81%, Japan was up 0.07% and Hang Sang was down 0.41%.

The Dow should open moderately higher as European data was stronger than expected. The 10-year is off 11/32 to yield 2.21%.


A Light Volume Rally In A Very Quiet But Nervous Market

By: Kent Engelke | Capitol Securities

Did the markets breathe a general sigh of relief that a major geopolitical event did not occur over the weekend? That was the accepted narrative for yesterday’s light volume advance. I found it disturbing that North Korea is still making bellicose statements, statements that most are taking as bluster.

I ask however, does the Trump administration share the same view? It was reported, albeit unconfirmed, the US is sending two more aircraft carriers to the waters off Korea. Is this the ultimate example of “Battleship Diplomacy?”

I vividly recall examples as to how the markets can be held hostage to every geopolitical event, both real and perceived. The complacency at this juncture is perhaps disturbing especially if Kim Jong Un is indeed this deranged paranoid lunatic as projected, since predicting the true intent of one’s actions in this state is close to impossible.

Markets were also relieved by Chinese data that was slightly better than expected.

Speaking of China, it was reported in the late afternoon that the US has received encouraging signs that China will pressure the Korean regime to dismantle its nuclear weapons program, a catalyst for a further advance.

Earnings season accelerates today. This week, several mega sized firms are posting results including Goldman Sachs, Bank of America, NetFlix and IBM. How will these results be interpreted?

Last night the foreign markets were down. London was down 1.62%, Paris was down 1.18% and Frankfurt was down 0.56%. China was down 0.79%, Japan was closed for a holiday and Hang Sang was down 1.39%.

The Dow should open nominally lower ahead of several earnings that exceeded expectations. The French election on Sunday is beginning to make headline news. Will the populists win another victory or will the establishment prevail? The answer I think is pivotal. The 10-year is up 6/32 to yield 2.23%.


Earnings, Consumer Confidence, Housing Prices and MOAB

By: Kent Engelke | Capitol Securities

Thursday, stronger than expected earnings from two mega sized financials helped boost shares of financial companies. The dollar was little changed and Treasury bonds lower in the wake of the President’s comments on currencies, interest rates and support for FRB Chair Yellen.

Consumer sentiment also rose to a three month high in April and optimism about their current financial situation and the economy reached the strongest point since November 2000, according to the University of Michigan sentiment survey.

What I think is significant in the Michigan data is the “favorable home buying attitude” index is now held by 82% of respondents, the most since 2005 and just below the record of 84% in 1999.

I think this is significant for a number of reasons. First, the 2008-09 crisis started in residential real estate and is perhaps now at its official end. Second, most people judge their net worth not by the value of their stock portfolio, but by the value of their homes, hence a strong rationalization for the highest level of “current financial situation” index since 2000. Finally, the odds now favor an increase in Owners’ Equivalent Rent (OER) or what someone thinks they can rent their homes for if it was indeed a rental.

OER is a major component of all inflationary indices and such has been essentially flat since 2009 after plunging in 2008. This flat lining is a major reason why inflationary expectations have remained “well anchored.” If OER rises, so does inflationary expectations.

Speaking of potential inflationary expectations, weekly jobless claims are the lowest since they reached a 44-year low in the week ended February 25. Wow!

However, during March there was a tempering of wholesale prices as such declined for the first time since August 2016. Seventy-five percent of the decrease in the March PPI however was due to a drop in final demand service (goods manufactured destined to the consumer — includes commodities as oil fell by 2.9% from the previous month).

Trading Friday was initially quiet, so was the conversation until MOAB. Like most, I believe this was dropped to garner the attention of North Korea. However it also lifted the spirits of many of whom I speak with daily, making all us feel like the country is doing something about the deteriorating geopolitical environment.

The US citizenry is not immune to historical precedence. We don’t like being pushed around and taken advantage of, feeling a sense of pride when our country attempts to right a wrong. Yes, some can find fault with this statement, but PC 101 was not offered when I went to college.

Brinkmanship was the cornerstone of American foreign policy for 70 years, a span where global conflagration did not occur (Note: WWII commenced 20 years after WWI… in the Great War, 18 million died… in WWII over 100 million died or about 3.2% of the world’s population was killed).

In my view, MAOB instilled a combination of fear and pride, an event that may boost sentiment further in the immediacy.

This week’s economic and earnings calendar is crowded. Economic releases include retail sales, CPI, manufacturing data, various housing statistics and the Beige Book.

Last night the foreign markets were down. London was down 0.29%, Paris was down 0.59% and Frankfurt was down 0.38%. China was down 0.74%, closed Japan was up 0.11% and Hang Sang closed for a holiday.

The Dow should open nervously lower amid heightened geopolitical unrest. The 10-year is up 6/32 to yield 2.21%.


First Quarter Earnings Season Commences Today

By: Kent Engelke | Capitol Securities

First quarter earnings season commences today. As noted the other day, warnings are at the lowest point since inception of this data point…1999. At this juncture, analysts are expecting a 12% increase.

All markets were quiet yesterday until late in the afternoon when geopolitical issues became front and center. North Korea is again saber rattling. It was declared US/Soviet relations are at Cold War levels. The NASDAQ fell about 0.55% and the Dow was off about 0.39%. Oil was essentially flat, capping the longest rally since 2012.

As noted the other day, the volatility beneath the surface is intense. Four weeks ago, oil was getting crushed with the narrative very bearish, the result of a huge hedge fund selling. I think it is noteworthy that hedge fund buying was robust up to six weeks ago. Today, according to the CFTC, open interest is now at the greatest level for the year. In any regard, it feels as though an 18-month cycle is occurring in six weeks.

The Russell 2000 was down about 1.1% yesterday. Reiterating prior comments, the short interest in the Russell 2000 contracts have grown the most since 2008 according to Bloomberg.

Bloomberg writes the S & P 500 technology sector is now down for nine consecutive days, only the third such occurrence since its 1989 inception. May 2012 was the longest streak… 12 days.

Treasuries were also unchanged until late in the day, ending about 1/2 point higher.

What is the above suggesting? Many times I have opined about the impact of electronic based trading models, models that have again entirely co-opted the markets. Is this their last major “hurrah” as the global economy and geopolitical environment transitions into something different?

I would place the odds of such at 50%, but unfortunately only history will/can answer this question.

What will happen today? Equity markets are closed tomorrow for Good Friday. The Treasury market is open, albeit liquidity will be challenged given the potential dearth of participants.

Last night the foreign markets were down. London was down 0.56%, Paris was down 0.57% and Frankfurt was down 0.38%. China was up 0.07%, Japan was down 0.68% and Hang Sang was down 0.21%.

The Dow should open nominally lower. Three mega financials report profits today. One just announced and earnings exceeded expectations. The markets are confused by the contradictory remarks by the Trump administration, comments that appear to be backtracking on campaign declarations. The 10-year is up 2/32 to yield 2.32%.


Change Is The Only Constant…The Velocity Of Change Is Frightening

By: Kent Engelke | Capitol Securities

The Trump trade has officially been completely “unwound.” The 10 and 30 year Treasury yields have reversed themselves and are now at the lowest levels for 2017. Bloomberg writes the short interest in the Russell 2000 futures contracts have grown the most since 2008. Mega capitalized international growth issues are again outperforming.

Wow! Talk about change from January where Main Street — defined as the small and value caps — were surging over Wall Street and Treasury yields were gapping higher on hopes of regulatory and tax reform.

But the world has radically changed since January. Brinkmanship and nationalism — both patriotic and economic — is surging globally. The populist fervor in Europe is at levels not experienced since the 1930s. I believe this is not reflected in the markets for one primary reason.

As noted a gazillion times and according to the SEC, the markets have been co-opted by algorithmic and ETF trading utilizing technology over macroeconomic and geopolitical thought. Further referencing a December 2015 SEC statement, approximately 90% of equity trading and 95% of Treasury trading is done electronically and such an environment “has created an unbalanced playing field that is benefiting only a few.”

Bloomberg reported yesterday the number of stock and bond analysts are at an all-time low, a trend the newswires is projecting will continue into infinity given the vast proliferation and dominance of passive index trading where by definition the big gets bigger and the small gets smaller.

As noted above, the environment has radically changed. Historically, the markets are the greatest discounter of all events, but has this discounting mechanism broke because of the proliferation of ETFs and algo traders? Because of today’s trading mechanics, a strong argument can be made that yesterday’s performance is indicative of future performance, a phrase that it is forbidden in the securities industry.

I will argue yes, but I will also argue that reality will ultimately prevail, thus suggesting there could be a prolonged period of underperformance for the mega capitalized growth issues (a term in itself that is oxymoronic). When everyone already owns something or everyone is already following the same strategy, typically a prolonged period of underperformance commences.

Change is the only constant. What has changed however is the velocity of change. Ten months ago, few suggested today’s geopolitical environment where populism, economic and patriotic nationalism will again become the dominant philosophy and even fewer had suggested that brinkmanship will return to be the cornerstone of American foreign policy, the cornerstone that existed since 1945 and took a hiatus from 2009-2016.

Commenting about yesterday’s market action, the Dow was virtually unchanged while the NASDAQ fell almost 0.5%, perhaps the result of valuation concerns of the mega capitalized technology growth issues. Treasuries ended around session low yields.

What will happen today?

Last night the foreign markets were mixed. London was down 0.07%, Paris was up 0.10% and Frankfurt was unchanged. China was down 0.46%, Japan was down 1.04% and Hang Sang was up 0.93%.

The Dow should open nominally lower ahead of the commencement of first quarter earnings season and geopolitical uncertainty. Oil is quietly higher ahead of an inventory survey and Saudi Arabia’s comments that it is willing to extend production cuts. The 10-year is unchanged at 2.30%.


A General Sense of Unease is Settling Into the Markets

By: Kent Engelke | Capitol Securities

A sense of unease is in the markets. The world has changed dramatically over the past year where yesterday’s guideposts are perhaps no longer valid. The Establishment is clinging to yesterday’s status quo for power and in a desperate attempt to recover sunk costs.

Is the quote, “The more things change the more things remain the same,” appropriate?

At this juncture, the odds are favoring a world similar to the one that existed before globalism and multiculturalism became the primary mantra, a world that was prevalent for a vast period of “modern” history defined as since 1890. The globalist philosophy only commenced during the early 1990s, went on steroids in 2008 and perhaps began an incredible collapse starting last June.

Will economic nationalism, brinkmanship and patriotism continue to evolve and again become the dominant macroeconomic geopolitical drivers? The answer to this question is pivotal in determining the potential direction of the economy and markets.

I think yes.

Speaking of reversions, oil is again dictated by geopolitical issues. Crude is experiencing its longest run for gains this year as Libya’s biggest oil field suffered another outage. Even with this outage, Libya’s production is still greater than it was from 2011 through the vast majority of 2016.

The Syrian issue was an initial catalyst for the current oil advance.

For a gazillion years, any geopolitical unrest in the oil producing countries caused a spike in prices. From 2014 throughout most of 2016, any violence was largely ignored.

Commenting upon the equity markets, equities were quiet on geopolitical concerns even as oil shares advanced.

Last night, the foreign markets were mixed. London was up 0.60%, Paris was up 0.12% and Frankfurt was down 0.17%. China was up 0.60%, Japan was down 0.27% and Hang Sang was down 0.72%.

The Dow should open nervously quiet. The 10-year is up 5/32 to yield 2.35%. Oil is up again as Saudi Arabia announced that its oil production was the lowest since January, staying below the output level it pledged to maintain as part of a global deal to reduce crude supplies.